Examining muniland’s indices after the Libor scandal

The muni market’s overseer, the Municipal Securities Rulemaking Board (MSRB), is taking aggressive action to survey muniland indices following the Libor scandal. The board is asking index providers to disclose more about how certain indices are developed. The MSRB has no direct authority to regulate indices because, as with Libor, they are maintained by private companies and are outside of the board’s legislative mandate to regulate dealers. Alan Polsky, the current chairman of the MSRB, said in a press call that the board did not believe that there was any wrongdoing in this corner of the market, but that increasing transparency would enhance investor confidence. Here’s what he stated in a press release:

“Like other regulators, the MSRB is concerned about the transparency surrounding the development of market indices,” said MSRB Chair Alan Polsky. “We plan to review indices used by the municipal market – and develop educational materials about their use – to ensure that the market operates fairly and transparently.”

This is exceptionally good news because the municipal markets generally lag behind the equity markets in the transparency of their indices. You could easily calculate the value of the Dow Jones industrial average yourself, because information on all of the Dow’s components are publicly available. The same can’t be said for the Bond Buyer 20 index.

The indices about which we know perhaps the least, though, are tied to Markit’s municipal credit default swaps. They describe their CDS pricing process generally like this:

Markit receives contributed CDS data from market makers from their official books and records. This data then undergoes a rigorous cleaning process where we test for stale, flat curves, outliers and inconsistent data. If a contribution fails any one of these tests, we discard it. By insisting on the highest standards, we ensure superior data quality for an accurate mark-to-market and market surveillance.

The issue for muni CDS is that there is no reported data for actual CDS trades, so the “contributed CDS data” is nothing more than what six big banks think a given security is worth at a given time. These are opaque markets with very few players. At least for cash bonds we have reported trade data from the MSRB’s RTRS system.

When I asked MSRB Chairman Alan Polsky on the press call if the board would be looking into how muni CDS were developed he said that unfortunately it was out of their jurisdiction. I’m assuming that is because Markit is based in London. It is really odd that a data firm controlled by the major banks could set pricing levels for a U.S. market without any regulatory oversight. No sunlight there.

Otherwise this whole effort by the MSRB is a very good use of the bully pulpit. I look forward to the results.